A s Ross Perot might say, there's a great sucking sound coming from America's poor neighborhoods these days -- the sound of large chunks of paychecks and benefit checks flowing into the pockets of check-cashers, at five times what it would cost a typical bank to provide similar services.
Thanks in part to deregulation, bank branches have closed in low- income communities since the early 1980s, and check-cashing outlets have often taken their place. Meanwhile, another institution that more affluent Americans know only from old movies and short stories -- the pawnshop -- has made a big comeback among the poor. The flight of the banks not only means that the poor must now pay more for financial services; it also means their communities are losing the institutions that promote personal savings. It is an irony of the recent era of economic policy: While commentators regularly preach sermons on Americans'low rate of savings, public policy has contributed to the erosion of savings institutions for the poor.
The replacement of regular banks by check-cashers and pawnshops, or "fringe bankers" as they are known, ought to trouble people across the political spectrum. Whatever their other differences, liberals and conservatives generally agree that saving is a good thing and that public policy ought to encourage it. The historical development of many of America's financial institutions, from mutual savings banks to credit unions, reflects a long commitment to the promotion of savings among lower-income Americans.
Since the 1980s, however, progress in incorporating the poor into the banking mainstream has ground to a halt. Indeed, we may well be going backwards. Surveys sponsored by the Federal Reserve Bank show that between 1977 and 1989, the percentage of households holding a deposit account changed little among the four highest income bands, but in the fifth--the poorest--account ownership dropped more than 11 percentage points. And while the rates for whites hardly varied during that time, the proportion of minority households with a bank account dipped almost six percentage points.
Reasonable people differ about what or who (if anybody) is to blame for this decline. The primary cause is probably the decline in real incomes among the poor; adequate evidence to resolve questions about causation isn't available. But it cannot help that poor communities are losing access to banks. The rise of fringe banking, says Allen Fishbein, general counsel for the Center for Community Change, an advocacy group for low-income neighborhoods, "underlines the decline of the universal banking system."
Up From Under the Mattress
Early in the nation's history, commercial banks catered to the rich; everyone else stored what little extra money they had in the proverbial mattress. But, as Swarthmore economist John P. Caskey explains, in the 1820s and 1830s wealthy Americans with a sense of civic duty began to create a new kind of institution, the mutual savings bank, to target the growing middle class. Mutuals were cooperative savings banks that shared profits among depositors, hoping they would be so inspired by the exhortations in their passbooks ("a penny saved is a penny earned") to graduate to more traditional banks.
By the early twentieth century, visionary businessmen such as Edward Filene, of Basement fame, sought to widen the community of savers even further. They borrowed an idea from Germany that became known in America as the credit union--a nonprofit institution owned by lower- and middle-income depositors who shared the same occupation. Credit unions, with restricted lending opportunities but certain legal advantages over banks, continue to flourish today.
Also in the early part of this century, the government loosened regulations on finance companies. Finance companies, which today include such familiar names as Home Finance Corporation and the Money Store, lent money to lower-income customers whom commercial banks considered too risky. Meanwhile, borrowing another European idea, some civic-minded Americans opened non-profit pawnshops.
The most radical plan was the postal savings system, a simple savings and payment scheme operated, for most of this century, from post office counters. The system reached its apex before the Clutch Plague, when it offered just about the only federally insured deposit accounts. But after federal insurance was extended to commercial banks during the New Deal, the postal banks withered away until they were finally abolished in 1966.
In the years since, there have been further attempts to bring lower-income Americans into the banking system, from the advent of savings and loans to the Community Reinvestment Act of 1977 (and its strengthened revisions of 1989), which pushed banks to serve lower-income customers. Despite their many limitations, these efforts have, on the whole, succeeded in their central objective: banking and saving are far more common for most Americans today than they were when their grandparents were young.
The Banks' Getaway
With financial deregulation in the 1980s, the historical movement to include the poor in the financial mainstream came to an end. Deregulation changed the business of banking in lower-income neighborhoods in two ways. Banks have always had an incentive to close unprofitable branches, but the competition stimulated by deregulation pushed many banks to act on those incentives. With deregulation, they no longer needed approval for branch closings. Regulators also began to welcome policies favoring locations in affluent areas because they helped raise bank profitability. In addition, per-check fees and minimum deposit levels, once nonexistent, rose dramatically. Few doubt that this helped push away some lower-income depositors who once used banks regularly, despite the widespread offers of "no-frills" bank accounts.
With the traditional banks gone, fringe banking took off. The dimensions and sources of their growth have been laid out by Caskey in a new book, Fringe Banking: Check-Cashing Outlets, Pawnshops, and the Poor, published by the Russell Sage Foundation. Caskey found that telephone listings of pawnshops increased 80 percent in the five years leading to 1992 and that check-cashers doubled over four years in that period. According to the National Check Cashers Association, cashers now process 150 million checks a year worth $45 billion, generating about $790 million in fees. The few states that lack interest ceilings or have the highest ceilings, where pawnbrokers often charge 240 percent interest a year, are home to the majority of such shops. Caskey emphasizes that the profile touted by press reports--gritty, inner-city locations that serve a predominantly African-American clientele--is only accurate in the Northeast. Elsewhere, such outlets also operate in working- and middle-class neighborhoods, often suburban, and serve mostly whites.
A recent report on check-cashers wryly calls them "one of the few growth industries in lower-income communities." The report, by veteran consumer activist Mark Green, shows that despite population increases, since 1978 Brooklyn has lost 14.3 percent of its bank branches and the Bronx has lost 19.9 percent. Green, who is now the elected public advocate for the city of New York, reports that "in both boroughs, bank closings disproportionately affected the poorest neighborhoods." Check-cashing outlets, which were hardly new (and benefited from loosened rules on their locations), filled the void. From 353 establishments operating in New York State in 1981, such outlets increased by 44.5 percent by the early 1990s.
The disparity in access to banking services is apparent from another local study, sponsored by the Los Angeles city council. The council found that in a 40-square-mile region of South Central Los Angeles, 133 check-cashers and only 19 banks served 587,000 people in 1991. Nearby Gardena boasted 21 banks for 49,800 residents.
There is nothing new, of course, about reduced access and higher prices for services in poor communities. David Caplovitz described the phenomenon in a 1963 book The Poor Pay More, which focused on installment credit. Financial deregulation in the 1980s allowed banking services to follow the same pattern. Caskey estimates that a family of four earning $10,000 would today spend $211 using check-cashers for a year; at $16,500, a family would spend $325 a year and at $24,000 a year it would spend $456. Pawnshops take even bigger bite. By comparison, if the same families used banks, they would spend about $60.
B ut if they cost more, why are check-cashers and pawnbrokers booming? For one thing, fringe bankers have their finger on the pulse of low-income communities. Surveys suggest that customers are satisfied with the services they receive from check-cashers, which include convenient locations, flexible hours, short lines, ancillary services such as bus passes and lottery tickets, and, perhaps most important, immediate cash without waiting for a check to clear. Allen Fishbein, who works to convince traditional banks to return to low-income areas, admits that check-cashers were one of the few businesses to return to Los Angeles immediately after the 1992 riots. (They operated from the back of trucks.) Pawnshops, too, have long been willing to overlook a client's lack of creditworthiness when lending.
As a result, although surveys differ, at least a sizable minority of check-cashing customers also have deposit accounts. The problem is with the others, who too often have been robbed of the chance to own a convenient deposit account because of bank flight.
Defenders of the banks argue, correctly, that automated teller machines in low-income neighborhoods have filled in some of the banking-services gap. However, ATMs cannot compete with the range of services that check-cashers provide, nor can they serve the traditional educational functions of banks, such as teaching customers about different saving and borrowing options. Given the absence of marketing outreach by the banks in poor areas, it's hardly surprising that the check-cashers' customers--whom studies show to be not only poorer but also less educated than average--are unaware of the price advantages banks can offer.
Compounding the gulf between banks and the urban poor is a divergence in banking needs. Recent immigrants who send funds to their families abroad--a growing sector of the check-casher clientele--have less need for a savings account than for convenient wire transfers. Language barriers (combined with a lack of education and a dearth of banking experience) complicate attempts to explain consumer choices, so non-English speakers are tempted to stick with the easiest option, even if it is expensive. For all their convenience, ATMs can hardly handle such questions.
Substituting check-cashers for banks generates some indirect costs to the poor, beyond the higher prices for services. For one, patrons of check-cashing outlets only receive signals to spend, not to save (right down to the lottery machines). They are also prime targets for thieves: Green's report highlights a growing trend of robberies near check-cashing outlets. And the absence of local bank branches makes it difficult for many residents to get loans or other services a bank might provide. This not only worsens the historical problem of redlining--that is, when banks avoid loaning money to residents and businesses in low-income areas--but also creates a vacuum that fosters the growth of occasionally unscrupulous and often usurious mortgage brokers that satisfy the lending demand.
The larger worry in all this is the financial marginalization of the poor. A bank account symbolizes economic participation. It's also vital for building a credit rating, for example. The growing detachment of the poor from the culture of banking and saving threatens to push them even further from the middle class. It is unclear whether a general cultural shift de-emphasizing thrift may have contributed to the decline in account-holding by the poor. Even if it has, however, the flight of banks from low-income neighborhoods can only reinforce the declining sway of traditional economic virtues.
Back to Banks?
What can be done to make banks more accessible and to limit the cost of financial services to the poor? It is not necessary to repeal banking deregulation altogether, only to use some policy creativity. One limited response, already made by at least 11 states, is to set ceilings on check-cashing fees. A majority of states also regulate the interest rates offered by pawnshops. As long as states do not set limits so low as to prevent these businesses from operating--if they did, Caskey suggests, it would wreak havoc on low-income money management--replicating these rules elsewhere and strengthening enforcement could help eliminate exploiters and rogues from the business. Another idea is to require check-cashers and pawnshops to post the cost of their services in a clear and standard way.
These rules, however, would not necessarily promote better access to banks. One way to do that is to encourage local check-cashers to become de facto bank branches by offering no-frills accounts on behalf of a traditional bank. Participating banks would gain customers, check-cashers would retain their customer base, and the customers would gain security. Another idea is to get better mileage out of the federal Community Reinvestment Act, which was designed (not very stringently) to withhold government approval from banks unless they made an effort to serve all communities in the region where they did business. Regulators might mandate that laggard banks join in a consortium that would operate branches in low-income neighborhoods under a single name. This would be less onerous than requiring each bank to serve poor neighborhoods, and it would create a bank network experienced with the specialized needs of low-income customers.
Since many residents of low-income communities receive some form of government assistance, government checks provide another appealing means for reconnecting banks with the poor. A bill offered by Senator Howard Metzenbaum, Democrat of Ohio, in 1991 would have required banks to cash government checks for non-depositors. Critics point out, however, that this approach could weaken many of the small and marginally profitable banks already serving poor neighborhoods. A better alternative would be to expand the system of electronic benefit transfers--that is, bypassing checks altogether and offering benefits such as unemployment, Social Security, welfare, and veterans payouts by wire directly into deposit accounts. Currently, about half of Social Security and veterans' benefits are paid out electronically. The Clinton administration has released a plan to create an integrated electronic benefit distribution system and hopes to have it in place nationwide by 1999. Early feedback from Maryland's electronic benefits program, now about a year old, shows that four of every five users are satisfied.
Mark Ragan, deputy director of a federal task force on electronic benefit transfers, says the proposal was designed to reduce fraud, lost checks, and crime. As written, the proposal helps recipients gain experience with ATM machines, reducing their dependence on check-cashers and the need to hold on to large amounts of cash for weeks at a time. But the plan could easily include incentives for low-income recipients to open a savings or checking account--something that almost no other reform can promise.
P rivate-sector efforts can also help. New non-profit credit unions, which would enjoy flexibility from banking requirements in exchange for a commitment to small depositors in the inner city, are a good idea. So too is the Clintonesque vision of new community development banks that would focus on commercial lending. Above all, banks need to recapture the momentum from check-cashers, filling the vacuum with their own brand of inventive and creatively marketed institutions. A useful model is offered by First Community Bank, a bank-within-a-bank operated by Bank of Boston.
Jeff Zinsmeyer, a director of the bank, says the idea sprung from the "not very novel notion that we should treat the low-income community as a separate business, just as we separate high-tech or transportation lending, or over-50 banking or private banking." The Bank of Boston opened the doors to its subsidiary in 1989 and, says Zinsmeyer, has been successful ever since.
A key move was to avoid what Zinsmeyer calls the "United Way" approach to banking--a charitable paternalism that annoys customers and saps management talent. "Who wants to be the guy who makes bad loans?" he asks. Rather, the bank saw the inner city as a business opportunity. New immigrants are one target market. Despite language barriers and low incomes, Zinsmeyer sees their market as stable, reliable, and set for growth. "If you were told that the market was growing at 10, 20, 30 percent, you'd want to be in," he says. Public-private partnership funds for community development have made it easier for the bank to make loans no other bank would touch.
To be sure, this kind of endeavor isn't for every bank, Zinsmeyer says. Rather, he suggests that legislative sticks might be less beneficial than carrots. And Zinsmeyer admits that there are limits to banks' usefulness. Because a single failed $100,000 loan can only be recouped, at present profit margins, by the successful repayment of 20 to 30 others, some loans really are too risky to make, he says. Rather than wait to build new institutions from scratch, he says, why not help endangered communities benefit sooner from the knowledge and infrastructure of experienced banks?
Creative coalition-building could help promote this kind of change. Jack Kemp, for example, has been building bridges with liberals on policies that give the poor an ownership stake in the economy. Chris Jacobs, who is policy director of the Kemp-affiliated Empowerment Network Foundation, says banking services are as central to their vision of community empowerment as it is for community activists. With a little luck and a lot of hard work, the next wave of low-income banking reform has the potential to be a bipartisan affair.
Recent news reports have noted that the popularity of ATMs and of banking by phone has made bank branches in affluent suburbs almost superfluous, putting these branches, for the first time, on the same closure lists long inhabited by branches in poor neighborhoods. This need not be a bad omen for the customers, and potential customers, in low-income areas. The chief advantage of ATMs is that they are both inexpensive and cost-effective. Thanks to ATMs, banks may now cheaply enter geographical niches that were once seen as unprofitable--and, once there, the machines' long-term cost-effectiveness will make banks more likely to stay put.
But ATMSs should not be seen as a quick technological fix. Just plopping teller machines in poor neighborhoods will hardly attract droves of new customers. Serious outreach is needed; a good start would be to plow a small portion of the savings from closed suburban branches into marketing efforts in poor areas. Moreover, the government must continue its regulatory pressures to insure that the precious few existing branches in low-income areas are not now closed. If banks decide to pursue this new market with a little creativity--using either the consortium model or the First Community Bank model--the time may be surprisingly ripe for a rebirth of private sector low-income banking.
